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Holiday pay – should it include commission and overtime payments?

The developing case law on holiday pay continues to pose a challenge for employers. In Lock v British Gas Trading Ltd and others C-539/12, the ECJ has noted that employers will need to include amounts in holiday pay to compensate employees for lost commission that they would otherwise have earned in the holiday period.

This case concerns the interpretation of the rules on holiday pay in the Working Time Regulations 1998 (which implement a European Directive). The ECJ held that the commission earned by Mr Lock (who was employed as an energy sales consultant) for the sales he secured for British Gas was intrinsically linked to his role as a salesman, which meant that an element of commission had to be included in his holiday pay. The primary reason for the ECJ's decision was that it viewed the inability to earn commission during annual leave as a disincentive to take annual leave and it is a fundamental principle of European law that workers must not be deterred from exercising their right to annual leave.

The court decided that Mr Lock's holiday pay had to include three components:

his basic pay;

any commission falling due for payment while he was on annual leave; and

an amount equal to the average amount of commission he would ordinarily earn while working.

This question of whether holiday pay under the Working Time Regulations should include commission was referred to the ECJ by the employment tribunal, and the ECJ then found that it was for the national court to then decide exactly how the amount needed to compensate workers for lost commission should be calculated. The case is going back to the Leicester employment tribunal to decide this point.

This decision could have a significant impact on employers who operate commission schemes and potentially any other remuneration or bonus scheme that is related to individual performance. Such employers could face unlawful deductions from wages claims from employees who earn commission, seeking additional commission payments for periods of annual leave already taken.

If so, employees may be able to bring claims for unpaid holiday pay going back over a number of years and we will need to wait for decisions from the Tribunals to see whether they take a pragmatic approach and limit how far back employees' claims can go. There may be practical problems if employers do not have payroll records going back as far as the holiday year an employee is claiming unpaid holiday pay from. However, employees will not be able to claim back pay for holiday beyond any year in which they were actually paid the right amount of holiday pay and it will therefore be important to examine an employee's pay and work history very carefully before paying out on claims.

Decisions of the ECJ in individual cases like this interpret the effect in national law of the original Directive, they do not automatically have horizontal direct effect in other cases. This means that this interpretation of the European statute can’t be relied upon by individuals as against other private sector employers until a case gets to the EAT which decides that the existing legislation can be read in compliance with the judgment, or the UK government legislates to give effect to the ECJ's decision, but it is potentially a very significant stepping stone.

The Lock v British Gas case only deals with commission payments, not overtime or bonus payments, but is not the end of the story. There are a couple of further cases to be heard this summer which concern whether non-contractual overtime payments should be taken into account as part of the calculation of a week's pay when calculating holiday pay (the difference from the position now being that currently, the law only requires employers to take account of contractual overtime pay).

The main case to be decided in the summer is Neal v Freightliner Limited ET1315342/12 (the “Neal case”), in which it was decided, (but only at Tribunal level, which cases are not binding on other first instance Tribunals) that an employer should take overtime payments into account when calculating holiday pay.

The Neal case

The tribunal in Neal decided that Mr Neal was entitled to holiday pay that was not based solely on his basic salary. He was entitled to have other components taken into account, including non-contractual overtime, on the basis that they were intrinsically linked to the performance of the tasks he was required to carry out under his contract of employment.

The work N did as overtime and at weekends all amounted to the performance of tasks that he was required to carry out under his employment contract. The fact that N had volunteered to perform those tasks at times outside that which his contract required did not mean that performance at those times was no longer “intrinsically linked”.

The decision in Neal is that where a worker’s hours of work and therefore pay vary from week to week, holiday pay must be calculated on the basis of the “average weekly remuneration (including overtime) in the period of twelve weeks” before the holiday is taken. In comparative situations to that of N the claim would most likely be a claim for unlawful deductions from wages against their employer for the underpayment of holiday pay in relation to the holiday pay difference.

A potential risk for employers with a large overtime bill is that if the EAT in Neal finds against the employer then workers who work overtime will be able to make a claim for loss of holiday pay going back 6 years. There is a 3 month time limit for bringing a claim, from the last in a series of deductions, so workers who are no longer in the business would be unlikely to be able to bring claims.

Points to note

The Neal case is likely to relate only to the 4 weeks’ holiday pay that workers are entitled to under the European Directive, not to the additional 1.6 weeks’ holiday pay that workers are entitled to under the WTR.

The case allowed N to recover retrospectively the underpayment of holiday pay going back to the commencement of N’s employment (2007), but the limitation period for civil claims is six years.

N worked overtime every week of the year and it may be that a distinction could be drawn on the facts for cases in which, for example, overtime is seasonal or dependent on peaks in activity.

Action

We recommend that where overtime and holiday pay could be an issue for a business, based on the Neal decision, employers should undertake a confidential internal analysis, where records allow, of contingent liability e.g.:-

overtime worked over at least the last holiday year, (and you may want to go back over the previous 6 holiday years) in order to establish what the cost might be if claims were brought;

when each employee took their holidays for the previous six years. Calculate the average weekly remuneration in the preceding 12 weeks before the holiday was taken;

what was paid to the worker, compared to the pay if overtime were included (in order to establish the potential liability for each worker);

the company’s overtime arrangements, reviewing such arrangements as appropriate. For example:-

whether workers tend to work overtime in particularly busy times; and

the tasks generally undertaken during overtime. Do the tasks generally undertaken as part of overtime, amount to tasks intrinsically linked to work required under the employee’s contract of employment?

Options

Some employers have considered increasing holiday pay now to include overtime. This would “start time running” to bring claims for unlawful deductions from wages. Workers would have three months from the date you change the calculation to bring a claim in the Tribunal. For many employers however, this is an unattractive proposition - if holiday pay is increased to take into account overtime and Neal is subsequently overturned employers may find that holiday pay has been increased unnecessarily going forward.

A more conservative approach would be to carry out a suitable analysis now but then wait until the outcome of any appeal is known. If the Neal appeal outcome is in favour of the employee then employers could decide whether to implement the increase going forward only - with perhaps a one off lump sum to “buy out” the past underpayments or pay based on internal analysis; perhaps with a global settlement with any recognised union and/or settlement agreements.